The focus in Congress continues to be on the Budget process and movement of the 12 appropriations bills, while the Presidential campaigns and primaries dominate politics and policy agendas in Washington. President Obama’s nomination of Merrick Garland to the Supreme Court has heightened political debate in the Senate between Republicans and Democrats. Senate Minority Leader Reid (D-NV) has stated that he will not attempt to obstruct the movement of the appropriations bills in order to get leverage in the battle for consideration of Judge Merrick, although Democrats could still decide to challenge advancing the spending bills for other reasons, specifically if the Republicans attempt to add controversial riders to the legislation.
House Speaker Ryan continues to pursue his plan to move a Budget Resolution approved by the House Budget Committee through the House, but Republican conservative members continue to state that they will oppose a Budget Resolution based on the 2-year budget deal agreed to in 2015 because the spending cap is too high. Committee work has begun in the House on individual appropriations bills, but they cannot be brought to the House Floor without an approved Budget Resolution until May 15th when House leaders can bring the bills to the Floor even if the annual budget resolution has not been adopted. In that case, however, it would be very difficult for the House to approve all 12 spending bills by October 1st, when FY 2017 begins, especially in light of the shortened legislative schedule due to Congressional recesses for the two political conventions. Failure to approve the appropriations bills would likely lead to a short-term Continuing Resolution at current spending levels with the possibility of a lame duck session to consider these issues.
In the Senate, there is less interest in advancing a Budget Resolution. Republican leadership is willing to follow the 2015 agreement, although this would mean that there is no opportunity in the Senate to move budget reconciliation legislation (a fast-track procedure that limits debate in the Senate and allows for passage of certain legislation by a simple majority vote as opposed to the 60 votes needed to overcome procedural hurdles such as the filibuster). Thus, the regular appropriations procedures are moving forward.
The House Republican budget plan calls for Congress to enact tax reform that consolidates and lowers individual tax rates, reduces the corporate rate, repeals the Alternative Minimum Tax, simplifies the Code and transitions to a more competitive international tax system – the same goals included in the 2015 Budget Resolution. Although there will be significant debate and discussion about international tax reform in 2016, most members of Congress believe that comprehensive reform will have to wait for a new Administration.
The international tax reform debate has included serious consideration of a patent/innovation box proposal, which has bipartisan support among members of the tax-writing committees. The Assistant Secretary for Tax Policy and the Chair of the White House Council of Economic Advisers have both now come out in opposition to this concept. Innovation boxes give companies a reduced tax rate on profits that are derived from intellectual property.
The House Tax Reform Task Force held its first meeting, and future discussions are expected to include consideration of consumption taxes in addition to comprehensive reform of the income-based system. The work of the Task Force is intended to help lay the groundwork for tax reform in 2017. Ways & Means Committee Chair Brady (R-TX) has laid out a set of principles to guide his work as the head of the Task Force following this Mission Statement: Create jobs, grow the economy, and raise wages by reducing rates, removing special interest carve-outs, and making our broken tax code simpler and fairer.
The W&M Tax Policy Subcommittee held a hearing on March 22nd on several tax reform bills introduced by House lawmakers that propose moving away from income as the tax base and instead looking to cash-flow or consumption. The Tax Policy Subcommittee will hold a second hearing on April 13th to review tax reform bills introduced by House lawmakers that make fundamental reforms within the context of an income-based system.
A revised international tax reform draft, which had previously been expected to be released by the Tax Policy Subcommittee in March, will be delayed, although W&M Committee Chair Brady continues to suggest that the Committee will take up international tax reform in Committee during 2016. Congressman Levin (D-MI), the senior Democrat on the Committee, has introduced a bill targeting “earnings stripping” and corporate inversions.
Senate Finance Committee Chair Hatch (R-UT) continues to work on draft legislation on corporate integration and inversions but no release date has been announced beyond his suggestion that May is a target date for the work, subject to the Joint Committee on Taxation (JCT) analysis of the proposal’s revenue impact. Senator Wyden (D-OR), top ranking Democrat on the SFC, is drafting an inversions bill covering hopscotch loans and “spinversions” (spinning off parts of a US company into a foreign entity). SFC members Brown (D-OH) and Schumer (D-NY) have introduced bills targeting inversion transactions.
In March 2016, the JCT issued its annual “Blue Book”, which is a summary of tax legislation enacted in 2015. It is prepared by the JCT staff in consultation with the staff of the House and Senate tax-writing committees. For each tax law change, the document includes a description of the law prior to enactment, an explanation of the provision and the effective date. The report covers the revenue provisions of 13 bills enacted in 2015, including the “Protecting Americans from Tax Hikes Act of 2015” (PATH Act), which was a part of the Consolidated Appropriations Act, 2016.
Treasury and the IRS issued final regulations under the Foreign Account Tax Compliance Act (FATCA) that define how certain non-individuals (corporations, partnerships or trusts) will be considered a specified domestic entity required to report specified foreign financial assets under Code section 6038D. The final regulations are effective February 23, 2016, and adopt the provisions of proposed regulations issued in December 2011 with some changes. Specifically, the final regulations eliminate the principal purpose test for determining whether a corporation or partnership is a specified domestic entity and adopt several modifications to the term “passive income.” Treasury and the IRS will continue to monitor whether domestic corporations and partnerships not required to report under these final regulations are being used inappropriately by specified individuals to avoid reporting.
Treasury and the IRS issued final and temporary regulations relating to the taxation of, and withholding on, foreign persons upon certain dispositions of, and distributions with respect to, US real property interests (USRPIs). The regulations reflect changes made in the PATH Act. The rate of withholding of tax on dispositions of USRPIs increased from 10% to 15% (by amending Code section 1445) with an exception in the case of a disposition of property that is acquired by the transferee for his or her use as a residence where the amount realized is between $300,000 and $1 million. Treasury and the IRS requested comments regarding what regulations should be issued under section 897(l), which provides that section 897 does not apply to USRPIs held directly (or indirectly through one or more partnerships) by, or to distributions received from a REIT by, a qualified foreign pension fund or entity wholly owned by a qualified foreign pension fund.
The IRS Large Business & International (LB&I) division has finalized Publication 5125, which sets forth the new LB&I examination process. The new process will take effect for new cases starting on May 1, 2016, and the IRS has stated that it will issue updates to the Internal Revenue Manual on or before that date. The new examination process follows an organizational approach for examiners to conduct examinations from the initial contact with the taxpayer through the final stages of issue resolution and provides an overview of the three stages of the process: Planning, Execution and Resolution. The new process reflects a shift to an “issue-based approach” for the IRS when conducting audits of taxpayers, and critical components of the process are increased transparency, enhanced communication and improved collaboration between the exam team and the taxpayer.
The IRS issued Revenue Procedure 2016-19, which describes procedures for taxpayers and other entities to submit issues for consideration under its Industry Issue Resolution (IIR) Program. The IRS explains that the IIR Program works to identify and resolve “frequently disputed or burdensome tax issues that affect a significant number of business taxpayers through the issuance of guidance.”
Treasury and the EU State Aid Investigations: European Commissioner for Competition Margrethe Vestager has responded on behalf of the European Commission to a letter sent in February by Treasury Secretary Lew which claimed that US companies appear to be targeted by the State Aid investigations being conducted by the European Commission Directorate-General for Competition. Her response stated that the State Aid investigations complement the BEPS initiative and “aim at a proper, non-discriminative, application of tax laws in Europe.” A group of Senators (including SFC Chair Hatch (R-UT), SFC Ranking Member Wyden (D-OR) and Senators Portman (R-OH) and Schumer (D-NY)) have urged Treasury to consider invoking Code section 891, which would allow the President to impose double taxes on corporations and people from countries deemed to be levying discriminatory or extraterritorial taxes on US entities.
OECD Base Erosion and Profit Shifting (BEPS) Project: The OECD has agreed to a new proposal that provides a framework that will broaden participation in the BEPS project. The new forum will allow all interested countries and jurisdictions (particularly developing countries) to participate as BEPS Associates in an extension of the OECD’s Committee on Fiscal Affairs (CFA). As BEPS Associates, they would work on an equal footing with the OECD and G20 members on the remaining standard-setting under the BEPS Project, as well as the review and monitoring of the implementation of the BEPS package. The framework’s mandate will focus on the review of implementation of the four BEPS minimum standards in the areas of harmful tax practices, tax treaty abuse, Country-by-Country reporting, and improvements in cross-border tax dispute resolution.
The Netherlands, which currently holds the presidency of the Council of the European Union, issued an EU-BEPS “Roadmap” on February 19, 2016, setting out plans to move forward with previous EU proposals as well as future proposals in areas related to the OECD’s Base Erosion and Profit Shifting (BEPS) project. The Dutch government stated that they would prioritize action against tax evasion and tax avoidance, including increasing transparency in efforts to tackle corporate tax avoidance and proposals for the conversion of BEPS measures into European legislation.
Included in the Roadmap is the goal of reaching consensus on the anti-tax avoidance directive proposed by the European Commission on January 28, 2016, which contains four key documents:
The enactment of EU tax directives requires full agreement from the 28 EU Member States because each member state retains sovereign legislative power in the area of direct taxation. The EC presents draft proposals, which are discussed in the Council of Finance Ministers (ECOFIN), and then Member States are given an opportunity to raise concerns and recommend changes.
The EU’s automatic information exchange Directive was recently expanded in scope to cover information exchange of advance cross-border tax rulings and advance pricing arrangements. This Directive would implement the OECD’s CbC reporting recommendations within the EU and would require Member States to implement the exchange of CbC reporting between competent authorities in relation to multinational enterprises (MNEs) for fiscal years beginning on or after January 1, 2016. The Directive provides that Member States should exchange the report with any other Member State in which, on the basis of the CbC report, one or more constituent entities of the MNE group are either resident for tax purposes or are subject to tax with respect to business carried out through a permanent establishment (PE). The exchange must take placed within 15 months after the last day of the MNE group’s fiscal year to which the CbC report relates, and the first reports must be exchanged for fiscal years beginning on or after January 1, 2016.
Anti-Tax Avoidance Directive (Anti-BEPS Directive)
This Directive is intended to establish a fixed framework for the 28 EU Member States to implement certain BEPS actions and other tax measures in a common form. The Directive is not completely in line with the BEPS Final Report recommendations and, in some cases, would require Member States to implement measures that the OECD did not agree to as being required “minimum standards.” The Directive includes rules addressing hybrid mismatches, limits on the deductibility of interest and controlled foreign company (CFC) rules, as well as some measures not included in the BEPS Final Reports – a general anti-abuse rule (GAAR), a switch-over” clause, and an exit tax.
Two or more Member States may give a different legal characterization to the same taxpayer/hybrid entity. This can result either in a deduction of the same payment, expense or loss both in the Member State in which the payment has its source, the expenses are incurred or the losses are suffered (the “source-State”), and in another Member State, or a deduction in the source-State without a corresponding income inclusion in the other State. The Directive proposes that the legal characterization given to the hybrid entity by the source-State should be followed by the other Member State(s).
The aim is to provide a fixed level of minimum protection to Member States, and an entity-by-entity limit on borrowing costs of 30% of taxable earnings before interest, taxes, depreciation and amortization (EBITDA), or 1 million Euros, if higher. Countries may chose to introduce an override if a taxpayer can demonstrate that its equity to total assets ratio is no more than two percentage points lower than the equivalent group ratio. The Directive also states that Member States may choose to introduce stricter rules. This recommendation differs from the OECD approach, which allowed countries to pick from the elements of each BEPS Action most suited to their current tax regime and tax competitiveness strategy.
Controlled Foreign Corporations (CFCs)
The CFC provisions would impose a charge on undistributed profits of controlled non-listed entities that are subject to taxation at an effective rate lower than 40% of the equivalent effective rate in the controlling Member State, where the entity principally receives financial income (e.g., interest), royalties, dividends, leasing income, certain real estate income, income from insurance, banking and other financial activities, and intra-group service income.
General Anti-Abuse Rule (GAAR)
The EC proposes that all EU Member States should adopt a GAAR to address gaps that may exist in a country’s anti-abuse rules and to counter certain forms of tax avoidance. The GAAR would target non-genuine arrangements or a series thereof carried out for the essential purpose of obtaining a tax advantage that defeats the object or purpose of the otherwise applicable tax provisions.
Most Member States have tax exemptions for dividend income and for capital gains on the sale of qualifying shareholdings. The EC has proposed that every Member State should adopt a rule whereby dividends and capital gains from low-taxed companies should not be exempt, but instead should be taxable, with a tax credit granted for any overseas tax actually paid. Low tax is defined as a statutory tax rate lower than 40% of the tax rate in the relevant Member State.
The Directive proposes an exit tax on specified transfers of assets or the transfer of residence that would require the EU Member State of origin to levy tax on the amount by which fair market value exceeds the tax book value of the assets. It has been a source of concern to some Member States that the European Court of Justice has ruled that Member States may not levy exit taxes when a company moves its tax residence to another EU country. The Directive goes further than cases on the transfer of residence with the additional provision that tax should be charged where assets are transferred from a head office to a branch.
The EC released a recommendation that Member States should include a principal purpose test in their tax treaties, although the text issued by the Commission varies somewhat from the proposal under Action 6 of the BEPS project. In addition, it also recommends that Member States adhere to the new proposed provisions to Article 5 of the OECD Model Tax Convention (with respect to the definition of PE) in their upcoming negotiations on tax treaties.
EU External Communication Strategy
The external strategy communication summarizes a number of issues relating to BEPS, the principles underlining the various anti-BEPS measures and the various measures and initiatives being taken within the EU. It sets out the EC’s view that a coordinated EU external strategy is critical to increase Member States’ collective success in tackling tax avoidance, ensuring effective taxation and creating a clear and stable environment for businesses in the single market.
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Robert M. Gordon
Managing Director & Assistant General Counsel